Monday, November 28, 2011

Economic Forecast Efficacy Of Recent Years

On November 25, the Liberty Street Economics blog (Federal Reserve Bank of New York) published a post titled "The Failure to Forecast the Great Recession."

The post examines the inability of the New York Fed, as well as the vast majority of professional forecasters in general, to predict the "Great Recession."  It also mentions the failure of forecasters to predict the decline in housing.

Although I found the entire post to be worthwhile, here are a few notable excerpts:
Economic forecasters never expect to predict precisely. One way of measuring the accuracy of their forecasts is against previous forecast errors. When judged by forecast error performance metrics from the macroeconomic quiescent period that many economists have labeled the Great Moderation, the New York Fed research staff forecasts, as well as most private sector forecasts for real activity before the Great Recession, look unusually far off the mark.
On the basis of their analysis, one could have expected that an October 2007 forecast of real GDP growth for 2008 would be within 1.3 percentage points of the actual outcome 70 percent of the time. The New York Fed staff forecast at that time was for growth of 2.6 percent in 2008. Based on the forecast of 2.6 percent and the size of forecast errors over the Great Moderation period, one would have expected that 70 percent of the time, actual growth would be within the 1.3 to 3.9 percent range. The current estimate of actual growth in 2008 is-3.3 percent, indicating that our forecast was off by 5.9 percentage points.
Using a similar approach to Reifschneider and Tulip but including forecast errors for 2007, one would have expected that 70 percent of the time the unemployment rate in the fourth quarter of 2009 should have been within 0.7 percentage point of a forecast made in April 2008. The actual forecast error was 4.4 percentage points, equivalent to an unexpected increase of over 6 million in the number of unemployed workers. Under the erroneous assumption that the 70 percent projection error band was based on a normal distribution, this would have been a 6 standard deviation error, a very unlikely occurrence indeed.
The post also examines more recent (April 2011) forecast performance, and finds that "the level of real activity in 2011 has been disappointing relative to expectations."

My comments:

Economic forecasts and their accuracy is of great importance for a variety of reasons.  It is because of this importance that this blog features many economic forecasts and financial market predictions.

I have previously commented on forecasters' inability to predict the adverse financial events of 2007-2010.   As well, a page titled "Predictions" serves as "a brief recap (in no way all-inclusive) of some forecasts and predictions that have been made during the Financial Crisis."

The accuracy of predictions prior to and during the "The Great Recession" serves as a reminder to how difficult financial crises, and their impacts, are to predict.  The inability to predict "The Great Recession" should serve to cast uncertainty on forecasters' ability to predict future severe economic weakness, especially since the level of complexity inherent in the overall economic environment is, according to my analyses, growing.

The Special Note summarizes my overall thoughts about our economic situation

SPX at 1194.85 as this post is written

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